The market got off to a strong start yesterday, up 1.6% from the get go, but the erosion began as President Obama’s news conference related to capping executive pay got underway – he obviously learned nothing from watching the Bush/Paulson press conference effect. Even consumer-related shares were holding up pretty well despite the misses from Kraft and Disney; however, by the time the afternoon session got underway most major industry groups were lower.
At 10ET we got the ISM service-sector index, as we’ll touch on in depth below, which offered its first sign of a bottoming since the mid-September collapse of Lehman that seemed to change the world. While it is too early to get excited about a bottoming in service-sector activity, the fact that this ISM measure improved should have helped stocks hold up. Since things began to break down you’ve got to say that press conference is what did it – and who can blame the market; enough is enough when it comes to government involvement. And who’s going to be screaming when financial-services jobs move overseas?
Market Activity for February 4, 2009
During that press conference President Obama stated the government will cap top executive pay at $500,000 for firms that have taken “significant” TARP funds.
What this means, of course, is the few large institutions that have not received significant (however that term will be defined) funds will be able to attract the top talent. Private equity firms will also be able to lure the best and brightest. This also increasing the likelihood talent will be moving overseas, much as the Sarbanes-Oxley regulation has driven IPOs away from the New York Stock Exchange and to the London and Dubai exchanges over the last few years.
In addition, we shouldn’t forget that it is regulators and the Federal Accounting Standards Board that has delivered the coupe de grace to the financial sector via fair value, or mark-to-market accounting rules. Banks would not have needed TARP funds in the first place if pro-cyclical accounting standards were not in place.
I understand the topic of executive compensation is a touchy one. Many people wonder how some in the industry are awarded such high compensation during a period when many terrible mistakes were made. But when the government gets involved in determining these things, it puts us on a dangerous course. As Justice Brandeis wrote, “the greatest dangers to liberty lurk in the insidious encroachment by men of zeal, well-meaning but without understanding.” Same is true when it comes to the economy.
It is also true that in many cases financial industry bonuses for the previous year’s results are paid in the first three months of the following year. So, some of what we’ve seen in 2008 pay was based on 2007 performance. There is no doubt that 2009 would have already shown a massive decline in compensation (2008 was down 40% from 2007 and the trend will continue in 2009), but now the government is involved in another market-price mechanism and I can’t view this as a good thing even if the vast majority of people are likely outraged by what they hear about executive pay. In its current form the caps are not a huge deal, but government intervention has a history of snowballing, which rolls us down a prosperity-killing path, and that’s the real concern. Watch, we’ll all be getting the bill for the New York bailout.
Preliminary Employment Reports
First, we had the Challenger Job Cuts survey (January), which tracks the number of announced layoffs for the month. The report estimated the number of layoff announcements picked up significantly last month – 241,749 vs.166,348 for December. Layoff announcements in January were 224.4% higher than January 2008’s level.
The bulk of the layoff announcements came from retail, industrial goods and computer & electronics sectors.
We’ll note that job-cut announcements are a lagging indicator; they generally peak after a recession has technically ended. We should expect that this data will be a good indication to the degree of official monthly job losses calculated by the Bureau of Labor Statistics for the next few months, but several months out it will not.
Second, we received the ADP employment report, which showed private payrolls fell 522,000 in January. This survey, via the largest employer services firm, had not been a great indication of what actually occurred in the labor market prior to the past few months, but its methodology has been changed to more closely mirror the way the government calculates things, so it has been close lately.
ADP stated service-producing employment fell 279,000 in January. Goods-producing jobs dropped 243,000 -- manufacturing shed 160,000 and construction down 83,000.
Small and medium-sized firms (defined as those with fewer than 500 employees) cut 430,000 positions, compared to a 92,000 decline for larger firms.
So, Friday we get the official monthly job report for January, and these data suggest (along with jobless claims and ISM employment) that it’s going to be another ugly one. We’re likely to see another 500K-plus drop in monthly payroll positions, although some expect it to be closer to 400,000 due to technical issues related to seasonal adjustments. (The retail industry added fewer holiday season jobs than usual, which may play havoc with the adjustment).
In any event, we will see a few more months of outsized monthly declines – outsized defined at a number greater than a 325,000 decline) but this deterioration should ease after that. Unless some sort of government response really backfires and causes major alarm within the private sector, we just won’t see the current level of weakness extend beyond another 3-4 months, in my view.
ISM Service Sector Index
The Institute for Supply Management stated its non-manufacturing index rose to 42.9 for January from 40.1 in December. (This is a composite index that equally weights business activity, employment, new orders and supplier deliveries).
The rise in the index is quite welcome, even if the level is nothing to get excited about just yet.
Both the ISM surveys (manufacturing and this service sector look) point to continued contraction in economic activity. However, if we can build on these mild improvements it may be signaling a turning point. We’ll be watching for ISM service to make its way closer to 50 and ISM manufacturing to inch its way to the mid 40s. If that occurs by April, an economic bounce may be in the cards by the third quarter.
For now we remain concerned regulators’ obstinance regarding pro-cyclical accounting will keep lending activity stagnant (see chart below) and the government spending spree will keep the private sector concern over future tax rates heightened, and their level of caution as well. We shall see.
(On the chart below, notice the spike in activity that took place August-October. This resulted from firms accessing credit lines for fear they would be taken away; it was not due to increased project activity – credit lines are set to models, when default rates rise banks almost universally pull back on lines of credit and firms got out in front of this move. During November and December we saw lending activity fall as the credit-line phenomenon ran its course. I’m expecting this contraction will be more pronounced as we get the January and February figures. Some of this will be part of the re-adjustment process, no problem there, but the accounting regime will exacerbate the situation and that is a problem.)
Have a great day!
Brent Vondera, Senior Analyst
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